Why Do We Need the Bitcoin Lightning Network?

Bitcoin as a global payment system?

Bitcoin offers numerous advantages as a decentralized payment system through which money can be sent worldwide without intermediaries. Chief among these is the low entry thresholds for participants: any citizen in the world with an Internet-enabled device can use the bitcoin protocol. No one can be excluded, which positively impacts financial inclusion. Moreover, Bitcoin represents a scarce digital asset, a kind of “digital gold.” Each bitcoin can be divided into 100 Million satoshis, just like you can split one euro into 100 cents. Unlike fiat currencies, according to the Bitcoin protocol, the money supply is limited to roughly 21 million bitcoin. Thus, a debasement via dilution of Bitcoin is impossible.

Lightning addresses Bitcoin’s disadvantages

The goal of the Lightning development is to make Bitcoin suitable for everyday use as a means of payment. The top priority is to increase payment throughput without centralization, which is the basis of payment networks, such as Visa or Mastercard. More specifically, this means more payments at mostly cheaper rates. While Bitcoin’s whitepaper was published by Satoshi Nakamoto as early as 2008, the idea of the Lightning Network dates back to 2015. The first implementations began in 2016. In 2018, the first users started to use Lightning implementations. Since then, the technology and the network have evolved rapidly. However, despite a heavy transaction volume and recent progress in adoption, it is still in its infancy in 2022.

How does the Lightning Network work in general?

To understand how the Lightning Network works, consider the following real-world example. Assume you are going to a bar with a few friends to have a fun evening. You want to invite them for drinks, but it is too burdensome for you to pay for every drink separately. Thus, you leave your credit card with the bartender to open a tab. Every time you or one of your friends orders a drink, the bartender keeps a tab. At the end of the evening, the bartender closes the tab and gives you the final bill to conduct the payment. Such bar tab payment is a common practice in the US and UK.

Conclusion

The Lightning Network is the next evolutionary step of Bitcoin. Bitcoin enables global transactions without intermediaries, but settling all payments via the Bitcoin Blockchain has limitations. Lightning can significantly increase payment throughput, which is necessary for Bitcoin to be widely used as a payment system. With Lightning, small payments can be made at a fraction of the cost, laying the foundation for an entire micropayment economy. We will discuss how exactly the Lightning Network works in detail in the second part of our article series.

About the authors

Dr. Jonas Gross is Head of Digital Assets and Currencies at etonec GmbH. Jonas holds a Ph.D. in economics from the University of Bayreuth (Germany), and his main fields of interest are central bank digital currencies, stablecoins, cryptocurrencies, and monetary policy. Further, Jonas is Chairman of the Digital Euro Association (DEA), co-host of the German podcast “Bitcoin, Fiat, & Rock’n’ Roll,” and member of the Expert Panel of the European Blockchain Observatory and Forum. You can reach Jonas via jonas@etonec.com.

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Jonas Gross

Jonas Gross

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Jonas Gross is Chairman of the Digital Euro Association (DEA) and Head of Digital Assets and Currencies at etonec. Further, Jonas holds a PhD in Economics.